Take a Load Off Fannie

Why won't the GOP's financial-crisis report follow the money?

Almost from day one, there have been rumors that the Financial Crisis Inquiry Commission, which the government established in the spring of 2009, was plagued by infighting between Democrats and Republicans. Lo and behold, on Dec. 15, defecting Republicans—former Calif. Rep. Bill Thomas; Keith Hennessey, who served on President Bush's National Economic Council; Douglas Holtz-Eakin, the former head of the Congressional Budget Office; and Peter Wallison, a fellow at the conservative American Enterprise Institute—broke ranks and released what they describe as their "preliminary findings and conclusions." This "primer" (in a blog, Wallison denied that it was either a "report" or a "response") put blame just where many Republicans would like to see it: on the government's push for homeownership.

"There were three important ways that the government pushed investors toward investing in mortgage debt," the authors write.

First, the regulatory capital requirements associated with mortgage debt were lower than for other investments. Second, the government encouraged the private market to extend credit to previously underserved borrowers through a combination of legislation, regulation and moral suasion. Third, and most important, during the bubble's expansion, the largest investors in the mortgage market … Fannie Mae and Freddie Mac, were instruments of U.S. government housing policy.

As a result of government-established affordable-housing goals starting in 1993, the authors argue, Fannie and Freddie had to "invest in mortgages of increasingly lower quality and higher risk to the taxpayer."

This narrative isn't completely wrong—but it is shockingly incomplete, which makes it, in the end, a ludicrous distortion of what happened. Yes, the government did lower the regulatory capital requirements for mortgages. But that didn't happen in a vacuum. Regulators did so in the face of fierce lobbying from the private sector. And while the government certainly did encourage the private market to extend credit, companies like Countrywide and Ameriquest didn't make mortgages—and Wall Street firms didn't package those mortgages and sell them off to investors—because the government was holding a gun to their heads. The mortgage companies and securities firms did what they did for one overwhelming reason: There was a huge amount of money to be made. As employees of Washington Mutual, which was one of the most prolific subprime lenders, rapped at a retreat in Hawaii in 2006: "I like big bucks and I cannot lie."

As for the implication that subprime lending began with Fannie and Freddie and resulted from the government's affordable housing goals, that's simply false. Subprime lending began in the 1990s with a group of other, nongovernment-affiliated companies more aggressive than Fannie and Freddie that sold the mortgages they made to Wall Street. These mortgages, for the most part, had nothing to do with putting people in homes. They were refinancings, not purchase loans, and they allowed people to use their homes as ATMs. Homeownership was just a convenient fig leaf—albeit one embraced by lenders and politicians alike.

For most of the 1990s, Fannie's and Freddie's affordable-housing goals required them to buy a certain percentage of mortgages made to families with a median income level. That was hardly onerous or risky, and anyway Fannie executives, who were far more preoccupied with return to shareholders, used to joke about the ways they neutered the affordable-housing rules. Indeed, there was an odd alliance between housing advocates and right-wing Republicans, both of whom complained—legitimately—that Fannie and Freddie weren't really doing anything to help homeownership. For Republicans to ignore now those earlier contentions in order to claim that it was the housing goals that gave birth to subprime lending is utterly dishonest.

The GOP report—oops, primer—provides a calculatedly incomplete account of how bad mortgages found their way onto the balance sheets of financial firms. There's an interesting dissection of the kinds of risk that banks took—but no mention of the reason they took those risks: They were making piles of money! As for the ways the risky mortgages were packaged into supposedly safe securities, all readers get is a whitewash. Collateralized debt obligations, or CDOs, which provided Wall Street with another way to launder bad mortgages into supposedly safe securities (and thereby keep the fee machine humming), are described as having "diversification benefits" that were simply "overwhelmed by the rising tide of foreclosures." No mention—zero—of "synthetic CDOs," which essentially allowed Wall Street to replicate the same bad mortgages over and over again, causing billions in losses. Nor is there any mention of the Street's failure to investigate the underlying mortgages, despite its promises to investors that it was doing so.

Oh, and here's the line about the credit-rating agencies like Moody's and Standard and Poor's, which made fortunes by stamping triple-A ratings on bundles of bad mortgages: "The credit rating agencies made many of the same mistakes as mortgage investors, and ratings on MBS proved to be severely inflated." Er, the mortgage investors were relying on the credit-rating agencies to do their job by assessing risk accurately. Anyone with even a rudimentary understanding of the 2008 crisis knows that. But apparently it never came up in those "hundreds of interviews" financed by taxpayer dollars.

Now, get ready for a few of the primer's breathtaking conclusions. "Put simply, the risk of a housing collapse was simply not appreciated." Shit happens. ("Bubbles happen" is, in fact, the first sentence in the report.) How about some exploration of why consumer advocates—who in the 1990s began warning the Federal Reserve and members of Congress that people were getting loans they couldn't pay back—were ignored? Here's another genius insight: "The panic ended when confidence returned." That one inspired me to check the definition of panic (a "sudden overwhelming fear") to make sure I wasn't wrong to find this a bit redundant. Daylight appeared when the sun rose. War ended when the armies stopped fighting. Hurt went away when the pain subsided.

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In fairness, the authors do attempt to address some important points, such as why it is that the subprime-mortgage market, which was small relative to the size of the global financial system, caused such enormous losses. But the explanation—that in essence, what happened to Wall Street was simply a "run on a bank"—ignores the active role Wall Street itself played in causing the run. If you sell hundreds of billions of dollars in bad securities to investors, and then those investors start to realize that you also own some of those same securities, well, there might just be a run. And a justified one at that.

Why did the crisis have such a devastating effect on the economy? "Given the wealth loss that households faced with the diminished value of their homes and the plunging of the stock market, consumers were scared, and they decreased their spending," the authors write. But there's more to the story than that. People had been spending by withdrawing equity from their homes. Now they couldn't do that anymore, and so they had no money to spend. They may not for a long time. Had the authors observed this chain of causation, they would have had to concede that the subprime-mortgage market was never really about homeownership. It was about what Wall Street is always about: money.